Q&A: Special Needs Trusts

By Sally J. Daugherty

Special Needs Trusts (also called Supplemental Needs Trusts) are trust funds that are set up for the benefit of person with disabilities who qualifies for Supplemental Security Income or Medicaid. The purpose of the SNT is to provide for those "extras" that are not covered by SSI or Medicaid without disqualifying the beneficiary from receiving SSI or Medicaid. They are useful because, if done properly, they do not qualify as income or assets that would count towards SSI or Medicaid qualification. A SNT will be a legal entity separate and apart from both the beneficiary and people who form and fund the SNT. It will have its own taxpayer identification number. This article will address some frequently asked questions regarding basic third party funded trusts for a person already qualified to receive SSI or Medicaid.

1. What is a Special Needs Trust?

A SNT is a legal device designed to make sure that money left to the beneficiary is used solely for the benefit of a person with a disability. It is used to pay for non-essential items for the disabled person, which is why it is called a special or supplemental needs trust. It is usually set up by a family member for the benefit of a person with a disability. It is managed by a trustee, who must have complete discretion over how the money is spent. It cannot be used to pay for things that SSI or Medicaid covers. It must designate a trustee and successor trustees and must state what happens to any balance left over after the beneficiary dies. If properly drafted, it cannot be accessed by the creditors of the beneficiary or anyone who put money into the trust fund. It also cannot be accessed by the beneficiary or by people who may try to influence the beneficiary, other than the designated trustee.

2. Should I put money in a trust fund now?

Money put into an SNT now can be used to pay for the beneficiary's current supplemental needs. It can be set up as a checking account to which funds can be deposited and withdrawn and you can serve as its trustee. The records of how you spend the money can serve as a valuable guide for how you want the money spent after you are gone. Since many of these expenses are tax deductible, it can provide good records for tax purposes. Family members who want to leave money to the beneficiary can name the trust fund in their wills, so they will not accidentally disqualify the intended beneficiary from SSI or Medicaid by an otherwise well meaning bequest. You should let family members know that you have established a trust, and also tell them that money left to the beneficiary in a will (and not to the trust) may cause the beneficiary to lose his or her benefits until the money is spent. You can also contribute money now, in case you do not have enough life insurance to fund the trust, or think that the money will be needed before you die. If your child has special needs about which you are concerned, but does not yet qualify for SSI or Medicaid, you can still set up a trust fund and put money in it now. The trustee can be directed to distribute the money in the future, if your child does not qualify for SSI or Medicaid by that time. If the beneficiary does not qualify for SSI or Medicaid, then you need not be concerned that the distribution will disqualify them. If you have concerns about the beneficiary's ability to manage their finances, you can still have a trustee administer the fund, and limit the use of the money as you see fit. In the alternative, you can direct that the money be distributed to a non-qualified trust that is not limited to paying for the beneficiary's special needs. If are not concerned about the beneficiary's ability to manage the money, it can be distributed outright to him or her.

3. Can I get money out of the trust if I need it in the future?

An SNT can be either revocable or irrevocable. A Revocable Trust, from which you can take back money, becomes part of your estate when you die. It will be counted as your assets for tax purposes, and can be used to pay any claims against your estate, including IRS liens. This is true even for life insurance proceeds going directly into the trust. However, you will be able to get your money out if you need to in the future. An Irrevocable Trust is created when you disclaim all rights to the money placed in the SNT, and cannot ever take it back or make a claim to it. You give it permanently to the SNT. You cannot get the money back, even if you become disabled in the future. However, the money will not be part of your estate. It will not be taxed as part of your estate when you die, and it cannot be used to pay any of your creditors, even if they have judgments against you or liens on your other property. The question of whether a particular SNT should be revocable or irrevocable depends many factors, including your age, the state of your own health, the size and nature of your estate, and whether you need to have the trust's assets be inaccessible to your creditors. There is not one best answer for every trust, and there are pros and cons to each. You should consult with an accountant, financial planner or accountant who can carefully review your own circumstances to guide your decision as to whether you should reserve the ability to get money back out of the trust.

4. What assets can be put into an SNT?

There are many resources that can be used to fund an SNT. These include the family's savings, military benefits and other standard government benefits for which a beneficiary is designated. Property such as real estate, investments, stock of both private and public companies, Certificates of Deposit, and Individual Retirement Accounts can be put into the fund. Parents and others can name the SNT as a beneficiary in their wills. Life insurance policies can also name the SNT as a beneficiary. Third parties can also contribute to the fund. However, money belonging to the beneficiary should not be put into the same fund as a third party funded SNT, as different rules apply for the disposition of any balance of a trust funded by the disabled person's own money.

5. What can the money be used for?

The trust document must designate that the money cannot be used to pay for the beneficiary's housing, medical treatments covered by Medicaid, food or clothing. It should also state that the money cannot be used to pay for any item that is or in the future may be covered by SSI or Medicaid and that any expenditure that would jeopardize the beneficiary's eligibility for SSI or Medicaid are not authorized. The trust should also specify any items unique to the beneficiary that you want to make sure are provided. The trust cannot be used for payment of the beneficiary's basic needs, such as housing, medical treatments, food or clothing. Money used for those purposes are considered "income" for purposes of determining the beneficiary's eligibility to receive SSI and Medicaid. The money can be used to purchase a home, which can then be rented to the beneficiary. The home will be part of the residue of the trust, and will be deeded over to whoever is designated to receive the balance of the trust fund after the beneficiary dies. The trust can pay for ordinary or special furniture, vacations, summer camp, trips, travel companions or other entertainment. It can be used for medical and health costs not covered by Medicaid, such as experimental and alternative medical treatments, massage therapy, vitamins, certain durable medical equipment and special aides. It can buy sporting equipment or fund hobbies. It can buy other useful items such as computers, haircuts, deodorant and razors, tickets to a ball game or a camera. It can be used to buy bowling shoes, but not regular shoes. The trust can also be used to pay for emergency legal costs, in the event that the beneficiary is sued, charged with a crime or needs an advocate to deal with government or medical red tape. It can also pay for the beneficiary's funeral and burial expenses. The grantor can designate specifically anything that he or she wants the trust to pay for, and can also specify things for which the money should not be used.

6. Who should be the Trustee?

One of the most difficult decisions may be the selection of a trustee to administer the SNT, invest its assets, and authorize spending. In order to be a qualified SNT, the trustee must have complete discretion over the disposition of the funds. The grantor may designate a trusted family member or friend, a lawyer, accountant or trust officer, or a combination of a loved one and a professional. The trustee or trustees must be willing and able to serve, and should be adequately compensated for their time, effort and risk. Even family members should be offered payment for their services, as it can be a very time consuming obligation. Professionals generally are compensated by payment of a percentage of the trust assets, and many will not administer smaller trusts unless they are paid on an hourly basis. Where there is more than one trustee, a dispute resolution mechanism, such as mediation or a designated "tie breaker" should also be considered. There are pros and cons to each category of trustee. Family members may lack the expertise to properly administer the trust, thus jeopardizing its intended purpose, creating adverse tax consequences and exposing its assets to third party claims. Family members may also have conflicts of interest in how the money is spent, and whether the principal should be depleted or preserved during the beneficiary's lifetime, particularly if the trustee is (or has a relationship with) a residuary beneficiary of the trust. The trustee may also be placed in an adversarial position with other family members, and may fear being accused of mishandling trust assets or not tending to the best interests of the disabled beneficiary. The trustee must also be capable of understanding Medicaid and Social Security regulations or of hiring someone who will monitor the Trust's compliance. An independent accountant, attorney or professional trust administrator may be in a better position to ensure that the terms of the trust instrument are met and that the assets are properly invested and administered. Their neutrality may diffuse difficult family conflicts and buffer the SNT from undue influences. They may also be best suited to monitor the SNT for relevant changes in the law, although a family member can also retain professionals to do so, and pay their fees from the SNT's assets. On the other hand, professional trustees are expensive, and may not be suitable to administer a smaller SNT. In addition, the professional trustee will not be as intimately familiar with the day to day and long term needs of the beneficiary as family members. The grantor must also designate a successor trustee, in the event that the initial trustee cannot or does not want to serve as the trustee any longer. It is best to name either an institution or a charity as a successor trustee, so as to avoid the uncertainty of a successor trustee being unable to serve at the end of the initial Trustee's service. Be sure to check with the entity first, in case they do not want to serve as the successor trustee.

7. Can the beneficiary of the trust have any say in how the money is spent?

The beneficiary cannot have any ability to direct how the money is spent. If the beneficiary has any ability to decide how the money is spent, or to compel the trustee to spend money in a particular way, then the money will be deemed the beneficiary's money, and not the trust. The money would then have to be counted as an asset of the beneficiary for purposes of determining eligibility for SSI and Medicaid. It could also be attached by the beneficiary's creditors and used to pay the beneficiary's debts. It is essential that all discretion over the disposition of the money in the trust be vested solely in the Trustee. Nonetheless, the beneficiary and family members must make the Trustee aware of the beneficiary's needs and wants, to guide the Trustee in the exercise of his or her discretion. This is especially true if the trustee is a professional trust officer or institution without intimate knowledge of the beneficiary's needs, interests and hobbies. You may also want to prepare a Letter of Intent to accompany the SNT instrument, which states in your own words, what you do and don't want the trust to provide, and what consideration should be given to the stated desires of the beneficiary. Although the Letter of Intent is not binding on the Trustee and cannot be used to limit the Trustee's discretion, it can serve as a useful guide to the Trustee, particularly after you are gone.

8. What is a "Pooled Trust?"

A "Pooled Trust" is a trust established and administered by a non-profit agency. It accumulates the money from multiple individual "sub-accounts" and usually can administer the fund more economically than individual trusts. The agency will tend to all of the investment decisions for the pooled trust, prepare its tax returns, pay its expense and monitor its compliance with applicable laws and regulations. The agency generally served as the trustee, and makes distribution decisions for the individual beneficiaries within its discretion. Participants must have a qualifying disability to open a sub account. 9. What happens to money left in the SNT after the Beneficiary dies? Third party SNTs must designate a residual beneficiary to receive any balance left in the fund when the disabled person dies. The SNT must name the beneficiary with specificity. If it simply states that the balance of the money should go to the beneficiary's heirs at law or to a beneficiary to be designated by the Trustee, it may be deemed a revocable trust, as discussed in Question 3. Any money remaining in sub accounts of a pooled trust after the beneficiary dies goes to the trust for the benefit of the other participants in the pooled trust. A trust funded by the disabled person's own assets, such as an inheritance, lawsuit settlement or savings accumulated before he or she became disabled, must contain a clause providing that certain government funded benefits will be repaid before any residue is distributed to another beneficiary.